The current crypto winter has seen the collapse of firms including big players such as Three Arrows Capital and Vauld. One of the primary catalysts for this was the de-pegging of the Terra USD (UST) stablecoin and the crash of the LUNA cryptocurrency.
Connecting the dots, it becomes apparent that there are close ties between centralised finance (CeFi) companies — crypto lenders and exchanges — and DeFi protocols. In fact, the relationship is such that flaws in any one protocol can have a cascading effect on a range of companies which rely on it.
At the Singapore Convention Week 2022 held on September 2, the Rising Temperatures panel discussion looked into issues of insolvency and restructuring surrounding crypto companies.
These matters have taken the spotlight in Singapore where companies affected by the crypto crash — such as Hodlnaut and Zipmex — have sought creditor protection to stay afloat.
Liquidating a crypto company
Kroll’s Jason Kardachi, who leads restructuring and insolvency work in Singapore and Southeast Asia, says that crypto companies pose a “uniquely challenging” situation for liquidators.
“The assets – where are they?” Kardachi questions, referring to the task of locating a company’s cryptocurrency holdings on the blockchain.
While all blockchain transactions are recorded and readily accessible, this data can be challenging to comprehend. Wallet addresses don’t identify their owners, and it can be difficult to figure out which wallets are managed by the company in question.
“In a situation where a company has petitioned for itself, it’s very important to get any cooperation you can from the management. They’re the ones who can direct you to where the assets are.”
Kardachi stresses that when it comes to insolvency, crypto firms are a lot different to deal with than traditional ones. The rapid growth of the industry has played a role in this.
“One example recently was this company which grew from US$10 million assets under management to US$1 billion within eight months. It’s getting money thrown at it,” he shares.
“Even if you tried really hard, how could you possibly keep up with that governance and the financial information you’re supposed to produce to track that appropriately.”
The lack of accounting standards and policies surrounding crypto management makes it difficult to account for the different holdings which a company might have. Blockchain transactions often exist as data dumps which require time and effort to sift through.
“Securing the assets and getting accurate information is absolutely essential,” Kardachi says about dealing with an insolvent crypto company.
Dealing with asset volatility
Another factor which liquidators have to consider is the volatility of crypto assets. “A lot of crypto companies out there are insolvent one day, and [solvent] the next.”
While managing assets on behalf of their users, companies use their own investing strategies and might have exposure to a number of different cryptocurrencies. As the value of these coins fluctuates, companies can shift in and out of being cashflow insolvent.
Normally, this wouldn’t be a cause for alarm. Say a company has US$1 million worth of deposits, but on a given day, the crypto markets are down and its investment portfolio is only worth US$750,000. At this point, the company can still facilitate the withdrawals which it expects on a day-to-day basis.
A problem would only arise if platform users wanted to withdraw funds exceeding US$750,000, all at once. This is what happened following the collapse of LUNA and USDT.
“An awful lot of people wanted their money back that day,” says Kardachi. Platforms which had exposure to these coins weren’t able to facilitate withdrawals, and thus faced the consequences of being insolvent. “Up until that point, their [solvency] hadn’t really been tested.”
Once insolvency becomes a legitimate problem, a crypto company is left with a number of considerations.
“Can you negotiate your way out of that? It’s pretty hard in these crypto cases because you could have [as many as] 300,000 creditors or customers, so who are you going to negotiate with? Can you trade your way out of that? But then you have the factors of volatility [that come into play],” explains Kroll’s Rose Kehoe.
The rights of crypto customers
When a crypto company faces insolvency, the relationship between the company and its customers takes the spotlight.
“Are the [crypto deposits] trust assets?” questions Rajah & Tann’s Danny Ong. This is important to help determine whether customers can seek legal recourse and recover their funds.
Fountain Court’s Nik Yeo suggests there’s no straightforward answer here. A lot of it comes down to each company’s T&Cs. “Whether a trust exists is fundamentally a matter of the party’s intentions. The most obvious place to find this intention is in the terms and conditions.”
Some companies protect themselves with risk warnings, clearly stating that funds may be at risk if the company goes insolvent. On the other hand, there may be companies which establish that any deposits are being held as trust assets. In the latter case, customers would have a stronger claim to their funds.
While determining whether a trust exists, it must also be taken into account that a company could have changed its T&Cs over the course of time.
“Which terms and conditions apply?” asks Jason Kardachi. “The ones when you bought the crypto and set up your account or the ones [which were updated] in lead-up to insolvency?”
“Unlike regulated financial institutions, [crypto] platforms may not even have historical copies of their terms and conditions,” Yeo adds. There’s nothing preventing them from changing their T&Cs in the lead-up to their collapse.
The Rising Temperatures panel made apparent a number of legal gaps when it comes to regulating crypto companies. The crypto winter has made these more apparent than ever, and only time will tell how they’ll be addressed by policy makers around the globe.
Featured Image Credit: Screenshot of Rising Temperatures panel discussion
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